Financial risk management
The information below is from the Annual Report 2020.
Foreign exchange risk
Foreign exchange exposures are monitored at the Business level, hedged at company level against the Group Treasury, and then netted and covered externally at Group level by the Group Treasury. All material fixed sales and purchase contracts, including both future cash flows and related accounts receivable and payable, are hedged. The estimated future commercial exposures are evaluated by the Businesses, and the level of hedging is decided by the Board of Management. Hedge accounting in accordance with IFRS 9 is applied to most of the hedges of these exposures. The hedges cover such time periods that both the prices and costs can be adjusted to new exchange rates. These periods vary among Group companies from one month to two years. The Group also hedges its position of the statement of financial position, which includes cash balances, loans/deposits, as well as other receivables and payables denominated in foreign currencies.
As field service work is invoiced in local currencies, there is some foreign exchange change related volatility in the consolidated net sales. However, the effect on the profitability is limited as the related costs are in the same currency. Spare part sales are based on a euro price list and related purchases in non-euro currencies are hedged, so the effect from foreign currency rate changes on spare part sales is minimal. As project/hardware sales/purchases, as well as estimated currency exposures from long-term agreements, are hedged, the Group does not expect significant gains/losses from foreign exchange rate changes in 2021 related to its operations, excluding internal financing.
The instruments, and their nominal values, used to hedge the Group’s foreign exchange exposures are listed in Note 5.7. Derivative financial instruments in the Annual report.
Since Wärtsilä has subsidiaries and joint ventures outside the euro zone, the Group’s equity, goodwill and purchase price allocations are sensitive to exchange rate fluctuations. At the end of 2020, the net assets of Wärtsilä’s foreign subsidiaries and joint ventures outside the euro zone totalled EUR 956 million (1,041). In addition, goodwill and purchase price allocations from acquisitions nominated in foreign currencies amounted to EUR 865 million (926). In 2020, the translation differences recognised in other comprehensive income mainly come from changes in the GBP exchange rate.
Approximately 65% (67) of sales and 61% (59) of operating costs were denominated in euros, and approximately 20% (20) of sales and 11% (10) of operating costs were denominated in US dollars. The remainder was split between several currencies. The Group’s profits and competitiveness are also indirectly affected by the home currencies (USD, GBP, JPY and KRW) of its main competitors.
Interest rate risk
Wärtsilä is exposed to interest rate risk primarily through market value changes to the net debt portfolio (price risk), as well as through changes in interest rates (re-fixing on rollovers). Interest rate risk is managed by constantly monitoring the market value of the financial instruments and by using sensitivity analysis.
Interest-bearing loan capital at the end of 2020 totalled EUR 1,161 million (908). The average interest rate was 0.8% (0.9) and the average re-fixing time 13 months (21).
Wärtsilä spreads its interest rate risk exposure by taking both fixed and floating rate loans. The share of fixed rate loans as a proportion of the total debt can vary between 30 and 70%. The Board of Directors has given authorisation to temporarily increase the share of fixed loans up to 100%, and the authorisation is valid until January 2022. Wärtsilä hedges its loan portfolio by using derivative instruments, such as interest rate swaps, futures and options.
Liquidity and refinancing risk
Wärtsilä ensures sufficient liquidity at all times by efficient cash management and by maintaining sufficient available committed and uncommitted credit lines. Refinancing risk is managed by having a balanced and sufficiently long loan portfolio.
Due to the COVID-19 pandemic, the liquidity reserves of the Group have been strengthened. The Revolving Credit Facilities (RCF) having maturity dates in 2020 were extended until the end of 2021, and their total amount was increased by EUR 20 million. The total amount of available RCFs, EUR 660 million, is fully unutilised. Other COVID-19 related funding arrangements resulted in disbursement of new long-term loans totalling EUR 190 million. As of 31 December 2020, the Group’s liquidity reserves were at high level and the liquidity position is expected to remain strong during 2021.
The existing loan facilities include:
• Committed Revolving Credit Facilities totalling EUR 660 million (640).
• Finnish Commercial Paper programmes totalling EUR 850 million (800).
The average maturity of the non-current debt is 36 months (46) and the average maturity of the confirmed credit lines is 21 months (30). Additional information in Note 5.6. Maturity analysis of financial liabilities.
At year-end, the Group had cash and cash equivalents totalling EUR 932 million (369), of which EUR 14 million (11) is related to assets held for sale, as well as EUR 660 million (640) of nonutilised committed credit facilities. Commercial Paper Programmes were not utilised on 31 December 2020 nor on 31 December 2019.
Committed Revolving Credit Facilities, as well as the parent company’s long-term loans, include a financial covenant (solvency ratio). The solvency ratio is expected to remain clearly over the covenant level for the foreseeable future.
Responsibility for managing the credit risks associated with ordinary commercial activities lies with the Businesses and the Group companies. Major trade and project finance credit risks are minimised by transferring risks to banks, insurance companies, and export credit organisations.
The credit risks related to the placement of liquid funds and to trading in financial instruments are minimised by setting explicit limits for the counterparties, and by making agreements only with the most reputable domestic and international banks and financial institutions. As only high credit quality (A- minimum rating requirement) counterparties are utilised for derivative financial instruments, and the transactions are made under ISDA Master Agreements, no credit losses are expected from these instruments.
The Group companies deposit the maximum amount of their liquid financial assets with the centralised treasury when local laws and central bank regulations allow it. The Group’s funds are placed in instruments with sufficient liquidity (current bank deposits or Finnish Commercial Papers) and rating (at least single-A rated instruments or other instruments approved by the Group’s CFO). These placements are constantly monitored by the Group Treasury, and Wärtsilä does not expect any future defaults from the placements.
The expected credit losses associated with investments carried at amortised cost are assessed on a forward-looking basis based on investment maturity dates, and counterparty credit risk on a quarterly basis. As of 31 December 2020, the expected credit loss was not material.
Equity price risk
Wärtsilä has equity investments totalling EUR 12 million (14) in power plant companies, most of which are located in developing countries and performing well according to expectations. Additional information is given in Note 5.2. Financial assets and liabilities by measurement category.
Capital risk management
Wärtsilä’s policy is to secure a strong capital base, both to maintain the confidence of investors and creditors and for the future development of the business. The capital is defined as total equity, including non-controlling interests and net interest-bearing debt. The target for Wärtsilä is to maintain gearing below 0.50 and to pay a dividend of at least 50% of earnings over the cycle.